Category Archives: Finance

Clearing up misconceptions about Islamic finance

November 19, 2017 By in Finance Tags: ,

Nizar Al Shubaily, an experienced Islamic banker, co-authors with me on Islamic finance. Although I believed that I was well versed in matters related to Islamic finance, the prevalence of misunderstood terms and concepts in the media and elsewhere have often confused matters.

Mr Al Shubaily has helped me understand a few things.

To start off, let’s take a step back and think about the meaning of interest in the financial sense. Interest is simply a fee paid on a debt, expressed as a percentage of some other number, usually the current or original amount of outstanding debt. There is nothing magical about using a percentage, or relative, amount to describe what is paid on debt as opposed to a fixed or absolute amount.

Does it matter if you say the fee is 10 per cent of an outstanding debt of US$100, versus a fee of $10? Not really. We also have to think about usury, defined as an unreasonably high interest charge or fee on a debt. Of course, it is not always clear what “unreasonably high” means in this context in terms of the general definition of usury.

Here we come to the first widespread misunderstanding in Islamic finance: it is commonly reported that “riba”, the Arabic word for payments with respect to debts (prohibited in Islam), is the equivalent of usury. But if this were true. then it would mean that if there is a level of interest on debt which is unjustified, then there must be a lower level that is justified. That is patently untrue. So what does riba, the prohibited action under Islam, actually mean? Continue reading →

Why the cash flow statement matters

November 10, 2017 By in Finance, Analysis Tags: ,

Cash flow for me is the most important financial statement as it can corroborate or invalidate what I see on the income statement. In the last three weeks I’ve looked at the income statements, balance sheet statements, and the link between the two for various companies. Today I will use Shuaa’s Q3 2017 financials to show how the cash flow statement can provide insight into the more famous income statement.

Cash flow basics

A little refresher course in accounting first. Cash flow accounting as a measure of the performance of a company is flawed because it does not reflect the timing of transactions. For example, if a company is paid an annual subscription to provide a weekly magazine, then cash flow accounting would recognise a large income upfront and then the expense of publishing the weekly magazine is recognised about evenly across the year. This can make things look far better than they are. There are other situations where the opposite could happen, or where the effect is on the balance sheet, eg depreciation. Continue reading →

Zombie companies can be harmful

August 28, 2017 By in Economy, Finance Tags: ,

The term “zombie company” has recently entered people’s lexicon as the phenomenon manifests itself in China. Yet this issue did not start with China, it is closely linked to the problems faced by Japan that started in the early 90’s, called Japan’s Lost Decade and sometimes the lost two decades, which arrested the development of their economy for at least a decade, even though the nation is known to be hard working and efficient. After all, Japan is the home of global super-companies such as Toyota and Sony so understanding how the economy stagnated could yield important lessons.

There are many closely related definitions for zombie companies but I will use one defined in the academic paper Zombie Lending and Depressed Restructuring in Japan published in the American Economic Review 2008. The definition that they give is:

A company with poor productivity and profitability that should have withdrawn from the market but continues to do business only thanks to support from creditors or the government.

Sound familiar? Continue reading →

SWFs as endowments

August 27, 2017 By in Economy, Finance, Government Tags: , ,

Different sovereign wealth funds (SWFs) have different mandates. The largest are presumed to have a mandate similar to that of an endowment. The idea is that the state owns a large but fixed amount of a valuable commodity, usually oil, and that this oil is the property of not just the living citizens but also of all future citizens. Therefore, some of the income from today’s sale of the commodity needs to be saved for the future. So in effect the SWF is a future generation fund.

The question becomes, how much needs to be saved to make this all fair? Well, one way to define fair is that the government expenditure per citizen across all time should remain the same, adjusting for the time value of money. Another way to state this is that the purchasing power per capita remains constant. I think that most reasonable people would consider this fair. Continue reading →

UNB kicks off earnings season

July 18, 2017 By in Finance Tags: ,

Abu Dhabi lender Union National Bank announced its second-quarter financials. On the face of it things look positive with an increase in net profit of 7.2 per cent relative to the same period last year and that net income from interest and Islamic financing, the core business of a bank, rose 2.6 per cent. However, a quick peek at the underlying fundamentals shows that core revenue from interest and Islamic financing grew 6.4 per cent whilst expenses for interest and Islamic financing grew 13.4 per cent.  Core expenses growing faster than core revenue is unsustainable. When you factor in that operating expenses grew by a whopping 21.1 per cent the picture looks less than sterling. The main driver for the increase in net profit is retail fees and recoveries which grew 43.7 per cent, an unsustainable growth rate for this profit line item.

Stay tuned as I take a deep dive into reported second-quarter earnings next week and uncover whether the net profit reported is quality or whether the underlying fundamentals are deteriorating.

Sabah al-Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more on his Twitter feed or for deeper analysis on LinkedIn and al-binali.com.

Softbank Vision Fund highlights how investors should analyse structures

June 15, 2017 By in Due Diligence, Finance Tags: ,

A Financial Times article recently described the structure of the SoftBank Vision Fund.

The details reveal breathtaking audacity in terms of SoftBank laying claim to investor returns without transfer of an equivalent level of risk. To avoid competing accounts, I will use the FT as my source of information, as I am not so much interested in what SoftBank is doing as I am in how investors might analyse such structures.

The tech and innovation focused fund has gained fame due to its size, currently a reported US$93 billion in commitments. Less broadcast is that SoftBank’s 44 per cent internal rate of return over the past 18 years is driven predominantly by two investments, Alibaba and Yahoo Japan. But the issue is not about investment ability, it is about whether the structure is fair.

Continue reading →

Unmasking business shenanigans

May 23, 2017 By in Finance Tags: , ,

I have recently pointed out that one of the warning signs that a business is facing issues is when core revenue, ie revenue from the main business lines, is down but profit is up.

Why the combination? Why not simply flag a drop in core revenue? Because it is normal for revenue to fluctuate – especially in a challenging economy. But if revenues go down and profit goes up, it means the business has miraculously had a major increase in non-core revenue or, worse, has made large cuts to expenses.
Large jumps in non-core revenue are rarely sustainable. They usually come from either re-valuing assets, an exercise that does not affect cash flow nor is it recurring, or from the sale of an asset at a price higher than it was held on the books, which helps cash flow but is non-recurring and may reduce income-generating assets.

On the expense side you have actual cash expenses that are reduced, usually employee compensation or number of employees, but this can also include things such as rent. These have a positive cash-flow effect but are limited in the number of times they can be done, not to mention that it can affect revenue generation by losing employees or reducing morale.
The red flag is when non-cash expenses change drastically, such as depreciation, amortisation and impairment charges. This is a red flag because it is relatively easy to massage these numbers, plus it has no impact on cash flow. Continue reading →

Board drama, and crunching the numbers on oil

May 9, 2017 By in Corporate Governance, Oil, Investments, Finance Tags: , ,

A few weeks ago I pointed out that Etisalat generated earnings of Dh0.97 per share and paid out Dh0.80 per share, which is a payout ratio of 82 per cent. I further pointed out that paying out such a high percentage of profits was consistent with a status quo strategy and inconsistent with an expansion strategy, which would need to use the earnings to expand. Last week Etisalat bid for Oman’s third mobile operator license.

The question is, is it rational to pay your shareholders nearly all of your profits and then to go on to expand? Etisalat saw its revenue drop in the first quarter although it managed to grow profit by cutting expenses. Still, with revenue falling, earnings being paid out and an expansion strategy, one is walking a tight rope.

I also recently analysed the 2016 financial performance of Gulf Finance House (GFH), a financial services group, in particular with respect to announced discussions with Shuaa Capital for a merger. The analysis showed a large loss from normal operations of about US$230 million masked by a one-time litigation award to show a profit. I was curious to see why Shuaa would be interested in GFH and so reviewed GFH’s Q1 2017 financials that were recently released. Perhaps GFH could engineer a miraculous turn around in normal operations.

The report showed that GFH has indeed achieved a profit of $33.5m for the quarter. An astounding achievement. I dug deeper. Financial services can have notoriously volatile earnings but one thing caught my eye: a profit of $25.6m from the sale of a subsidiary.

Upon closer examination, the profit came from selling a stake in a school.

The shares were received as part of the litigation settlement in 2016 and GFH valued this part of the stake at $29.4m. A year, or less, later they sold the stake for $55m for a profit of $25.6m. That is a return on investment of 87 per cent in at most one year. Did GFH generate a fantastic 87 per cent return in one year by its skill in operating the school?

Perhaps the whole market went up 87 per cent? Possibly the buyer and their advisers are clueless and overpaid by nearly double?

This one-off extraordinary transaction explains 76 per cent of the profit. I considered analysing if the other 24 per cent was one-off or normal recurring business, but why bother?

Union Properties last week announced that three of the directors of the board had resigned right after an AGM that appointed them. The three directors publicly denied resigning. There could be some chance that this is just a big misunderstanding. The more likely scenarios are less than salubrious.

Board drama is a red flag suggesting serious internal issues at a company. The number of such incidents in the market, along with going concern warning, capital injections at loss making companies, and law suits, will be a gauge of how much the oil price drop from 2014 is affecting our economy.

On Thursday, the price of oil dropped to its lowest level in five months. The main benchmark Brent fell below US$50 a barrel, followed by a modest comeback on Friday to about $49; as of Monday afternoon it was still at that level.

One reason for the drop was reported in a Financial Times article that quoted Jamie Webster, a fellow at the Center on Global Energy Policy at Columbia University: “Opec extension is baked into market expectations, but roaring shale growth makes the sizeable but too small a cut completely lose its potency.” A separate FT article stated that although the agreed Opec production cuts amount to 1.4 million barrels per day (bpd) the actual cut to exports might be as little as 800,000 bpd.

It is a little worrisome that Opec cuts production and oil prices pop up for only a short while. We keep hearing how oil prices will go up because of a lack of investment in oil infrastructure. Oil prices might pop up, but they keep dropping back down. If what you are hearing is different than what you are seeing, which should you believe?

In the investment world we have a phrase, “talking one’s book”. This describes the natural human trait of speaking positively about something beneficial to you, in this case the investments an investor has made. As investors and individuals who must make a myriad decisions based on the economy we should ask ourselves: if doing the same thing but expecting different results is a sign of insanity, then what is listening to the same thing and expecting different results a sign of?

This article was originally published in The National.